Page 371 - Accounting Principles (A Business Perspective)

9. Receivables and payables

This chapter discusses receivables and payables. For a company, a receivable is any sum of money due to be
paid to that company from any party for any reason. Similarly, a payable describes any sum of money to be paid by
that company to any party for any reason.

Primarily, receivables arise from the sale of goods and services. The two types of receivables are accounts
receivable, which companies offer for short-term credit with no interest charge; and notes receivable, which
companies sometimes extend for both short-and long-term credit with an interest charge. We pay particular
attention to accounting for uncollectible accounts receivable.
Like their customers, companies use credit, which they show as accounts payable or notes payable. Accounts
payable normally result from the purchase of goods or services and do not carry an interest charge. Short-term
notes payable carry an interest charge and may arise from the same transactions as accounts payable, but they can

also result from borrowing money from a bank or other institution. Chapter 4 identified accounts payable and
short-term notes payable as current liabilities. A company also incurs other current liabilities, including payables
such as sales tax payable, estimated product warranty payable, and certain liabilities that are contingent on the
occurrence of future events. Long-term notes payable usually result from borrowing money from a bank or other
institution to finance the acquisition of plant assets. As you study this chapter and learn how important credit is to
our economy, you will realize that credit in some form will probably always be with us.

Accounts receivable
In Chapter 3, you learned that most companies use the accrual basis of accounting since it better reflects the
actual results of the operations of a business. Under the accrual basis, a merchandising company that extends credit
records revenue when it makes a sale because at this time it has earned and realized the revenue. The company has

earned the revenue because it has completed the seller's part of the sales contract by delivering the goods. The
company has realized the revenue because it has received the customer's promise to pay in exchange for the goods.
This promise to pay by the customer is an account receivable to the seller. Accounts receivable are amounts that
customers owe a company for goods sold and services rendered on account. Frequently, these receivables resulting
from credit sales of goods and services are called trade receivables.
When a company sells goods on account, customers do not sign formal, written promises to pay, but they agree
to abide by the company's customary credit terms. However, customers may sign a sales invoice to acknowledge
purchase of goods. Payment terms for sales on account typically run from 30 to 60 days. Companies usually do not
charge interest on amounts owed, except on some past-due amounts.

Because customers do not always keep their promises to pay, companies must provide for these uncollectible
accounts in their records. Companies use two methods for handling uncollectible accounts. The allowance method
provides in advance for uncollectible accounts. The direct write-off method recognizes bad accounts as an expense
at the point when judged to be uncollectible and is the required method for federal income tax purposes. However,
since the allowance method represents the accrual basis of accounting and is the accepted method to record
uncollectible accounts for financial accounting purposes, we only discuss and illustrate the allowance method in
this text.

Even though companies carefully screen credit customers, they cannot eliminate all uncollectible accounts.
Companies expect some of their accounts to become uncollectible, but they do not know which ones. The matching
principle requires deducting expenses incurred in producing revenues from those revenues during the accounting

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